Western Digital Reports Fiscal Second Quarter 2022 Financial Results Transcript (Summary)

Peter Andrew: Thank you and good afternoon, everyone. Joining me today are David Goeckeler, Chief Executive Officer and Bob Eulau. Chief Financial Officer.

 

Before we begin, let me remind everyone that today's discussion contains forward-looking statements, including product portfolio expectations, business plans and performance, trends and financial outlook based on management's current assumptions and expectations. And as such, does include risks and uncertainties. We assume no obligation to update these statements. Please refer to our most recent financial report on Form 10-K filed with the SEC. For more information on the risks and uncertainties that could cause actual results to differ materially.

 

We will also make references to non-GAAP financial measures today. Reconciliations between the non-GAAP and comparable GAAP financial measures are included in the press release and other materials that are being posted in the investor relations section of our website.

 

With that, I will now turn the call over to David for introductory remarks.

 

David Goeckeler: Thank you, Peter. Good afternoon, everyone, and thanks for joining the call to discuss our second quarter of fiscal 2022 results.

 

We delivered strong results for the fiscal second quarter with revenue of $4.8 billion and non-GAAP gross margin of 33.6%, both of which are within the guidance range we provided last quarter. Additionally, we reported non-GAAP earnings per share of $2.30, which was ahead of our expectations. I'm proud of the team as this marks the seventh consecutive quarter of meeting or exceeding guidance amid a continuously increasingly challenged supply chain.

 

Before I go over the detailed results and business trends, I want to offer some important key takeaways coming out of calendar year 2021. First, we have made significant progress in strengthening our product portfolio. We delivered on our goals of qualifying our Enterprise SSD products at three cloud titans and two OEMs, commercializing energy-assisted hard drives, as well as commencing shipments of 20 terabyte hard drives based on OptiNAND technologies. These products address the large and fast-growing opportunities within the cloud for storage.

 

Second, demand for Western Digital storage solutions across cloud, client and consumer end markets remains consistently strong. We are optimistic about our outlook for calendar year 2022, as our customers continue to indicate solid demand across the end markets we serve. I'll share more about that demand and other macro factors later.

 

Third, we are continuing to navigate an increasingly complex supply chain, which is impacting both, our customers’ ability to ship products, as well as our ability to build products. In order to meet our end customers’ demand, we are incurring additional costs that will weigh primarily on our hard drive gross margins through the first half of calendar year 2022. These issues are transitory in nature, affecting both revenue and gross margin and we expect them to subside as the supply chain normalizes. We remain confident that the long-term growth and profitability opportunity in front of us has not changed.

 

Lastly, we received an investment grade corporate rating from Fitch in December, which represents Western Digital’s second investment grade corporate rating. This marks an important milestone as we have worked hard over the last 18 months to strengthen our financial position, providing us with greater financial flexibility in the future. As we approach our targeted debt levels, we look forward to reengaging in a capital return program in fiscal year 2023.

 

Turning to our results. This past quarter demand remained strong across our end markets and our customers and Western Digital teams continued to work diligently to mitigate the impact of supply chain disruptions. In particular, cloud revenue for the fiscal second quarter increased by 89% from the same period last year. We continue to anticipate strength in storage demand, which is bolstered by our ability to continue to bring innovative new products to market to meet the needs of the digital economy.

 

The potential of what can be accomplished through the creation of content and the ability to access digital information easily has never been greater. With our technology, we are enabling businesses, creators and innovators to think bigger and push their limits even further. Western Digital has built a great position in the large and growing storage markets. Our proven ability to innovate and develop a balanced portfolio, coupled with our broad routes to market, puts Western Digital in a strong position to capitalize on the many growth opportunities ahead of us.

 

I'll now recap our HDD and flash businesses. In HDD, overall cloud end market product demand remained high with revenue increasing 50% year-over-year, led by capacity enterprise hard drives. Although we were up strongly year-over-year, capacity enterprise hard drives declined sequentially after two quarters of strong shipments, partly due to some of our customers supply chain challenges.

 

As both, Western Digital and customers continue to face supply chain challenges, we will experience some near-term visibility issues. However, our overall demand signals continue to be very good as we move through the calendar year and we will be in a stronger position once these headwinds subside.

 

During the fiscal second quarter, we commenced volume shipments of our 20 terabyte CMR hard drives based on OptiNAND technology. We are very excited about OptiNAND, a revolutionary technology that utilizes flash in the control plane to further increase areal density. Additionally, we are seeing an increase in customer interest in adopting SMR technology and expect multiple cloud titans to deploy SMR drives in high volume later in this calendar year.

 

In flash, revenue grew in the second fiscal quarter due to seasonal strength in mobile and consumer. Within mobile, shipments of our BiCS5 products into leading 5G smartphones, increased over 60%, sequentially and 50% year-over-year led by strong content growth. BiCS5 shipments represented over 40% of total revenue. In BiCS5, production crossover took place during the quarter as expected. The successful ramp of BiCS5 helped accelerate our overall year-over-year bit shipment growth to 37% in the quarter.

 

Our WD Black premium SSD product line optimized for the best gaming experience continues to gain momentum, with revenue increasing about 50%, sequentially, and doubling in calendar year 2021. Along with flash products for gaming consoles, revenue has grown from zero to over 10% of our flash portfolio over the last two years. As consumers demand more [weighs] to access, generate and store content, whether via gaming, or the now emerging metaverse, our strong and growing flash portfolio will be integral to enable all of these applications.

 

In line with the guidance we provided last quarter, our client SSD business declined, sequentially, due to supply chain disruptions at some of our PC customers and pricing pressure in the more transactional markets. So far within the current quarter, we are starting to see pricing in the more transactional markets stabilize.

 

As I mentioned earlier, our Enterprise SSD products are qualified at three cloud titans and two major storage OEMs, marking significant progress compared to one cloud titan a year ago. As you know, this has been one of my top priorities.

 

Building upon the early success of ramping BiCS5 into mobile and gaming consoles, we are further strengthening our product portfolio as we move through calendar year 2022. In client SSD, the bedrock of Western Digital's flash portfolio, we have launched and are ramping BiCS5-based products in the fiscal third quarter with BiCS5 Enterprise SSD products later in the year.

 

For our next generation 3D Flash, we began initial commercial shipment of consumer flash devices based on our 162 layer BiCS6. Furthermore, we qualified and commenced revenue shipment of client SSD is based on QLC and BiCS5 technology in the fiscal second quarter. While still early in its evolution, we are starting to pave the way for the industry's adoption of QLC in the future. In our next generation, BiCS6 node will play an important role in that evolution.

 

Let me now offer a few observations on the demand environment. The accelerated digital transformation in the last two years has created a world that is more technology-enabled and technology-dependent than ever before. We anticipate these trends will continue to dry data storage growth across each end market we serve, cloud, client and consumer.

 

Our customers remain optimistic about demand trends in calendar 2022, driven by capital investment for the cloud build out, continued recovery in enterprise spending, growth in smart video applications, increased adoption and 5G phones, consumer gaming, and emerging trends such as VR/AR devices.

 

In cloud, our customers have announced a 36% year-over-year increase in capital investment for the cloud build out. This coupled with an increase in enterprise spending and continued growth in smart video applications is expected to drive growth for flash and HDD products into this growing end market.

 

In client, [PCM] demand has remained strong. Our customers are driving more consistent demand than the past several quarters and we see continued stabilization in 2022. PC unit shipment forecast continue to be robust and significantly ahead of pre pandemic levels. In addition, we anticipate an eventual return to site to drive a mix shift towards commercial PCs, which tend to offer richer client SSD content versus consumer-oriented PCs.

 

In mobile, the latest 5G phones have doubled NAND content from prior generation smartphones. We expect mobile device content to benefit as ongoing 5G adoption and new 5G-enabled applications are expected to drive the storage demand [in] both endpoints in the cloud.

 

In consumer, the highlight of this end market is our WD Black SSD line of products, optimized for gaming enthusiast. Revenue more than doubled in calendar year 2021. The consumer recognition of the strength and value of WD Black along with the SanDisk and SanDisk professional brands through a 34% year-over-year growth in average capacity per unit in consumer flash.

 

While end customer demand in calendar 2022 looks promising, supply chain challenges are increasing. This both, limits our ability to source components to meet customer demand and increases component costs. These costs are on top of the ongoing elevated logistics and health and safety COVID costs. While we believe these incremental costs are transitory and will subside as the supply chain conditions normalize, they will impact our results through the first half of this calendar year.

 

Let me now turn the call over to Bob who will discuss our fiscal second quarter results and provide a more detailed outlook for calendar year 2022. Bob?

 

Bob Eulau: Thanks, Dave, and good afternoon, everyone. As Dave mentioned, overall results for the fiscal second quarter were better than our expectations, marking the seventh consecutive quarter that we've met or exceeded guidance.

 

Total revenue for the quarter was $4.8 billion, down 4%, sequentially, and up 23% year-over-year. Non-GAAP earnings per share was $2.30, which exceeded the high end of our guidance range. Please note that this figure includes $70 million in total COVID related costs, which was higher than we anticipated entering the quarter. I'll provide more details on these costs in a minute, but we are pleased to deliver such strong results in the face of ongoing supply chain issues and COVID-related challenges.

 

In addition to this solid financial performance, we hit a major milestone this quarter in receiving an investment grade corporate rating from Fitch. This marks the company's second investment grade corporate rating. We are pleased to see that our work to build a stronger financial foundation is being recognized and is providing us with greater financial flexibility for the future. Additionally, we closed a public debt offering last December, and amended our loan agreement with lenders in January, bringing the maturity of over 85% of our debt balance to 2026 and beyond. For more details, please refer to our earnings presentation.

 

Turning to our end markets, cloud represented 40% of total revenue at $1.9 billion, down 14%, sequentially and up at 9% from a year ago. Supply chain disruptions impacted cloud hard drive deployments at certain customers, which led to a sequential decline in exabyte shipments in the fiscal second quarter. However, healthy overall demand for capacity enterprise drives along with Western Digital's leadership position at the 18 terabyte capacity point, drove a greater than 50% year-over-year increase in exabyte shipments.

 

The client end market represented 38% of total revenue at $1.9 billion, flat sequentially and down 1% year-over-year. The continued ramp of 5G phones helped offset decline in both, client SSD and client hard drive revenue, enabling total client revenue to stay flat. Client hard drives represent less than 15% of our HDD revenue.

 

Lastly, consumer represented 22% of revenue at $1.1 billion, up 9%, sequentially, and flat year-over-year. With a strong holiday season, retail flash led the sequential growth in consumer. On a year-over-year basis, growth in consumer flash was offset by a decline in consumer HDD.

 

Turning now to revenue by segment. We reported flash revenue of $2.6 billion, up 5%, sequentially, and up 29% year-over-year. On a blended basis flash ASPs were down 6%, sequentially, due to a seasonal increase in shipments to mobile and retail. On a like-for-like basis, flash ASPs were down 3%, sequentially.

 

Flash bit shipments increased by 13%, sequentially, and 37% year-over-year. Hard drive revenue was $2.2 billion, down 14%, sequentially, and up 16% year-over-year. On a sequential basis, total hard drive exabyte shipments decreased by 14%, while the average price per hard drive decreased by 5% to $97.

 

On a year-over-year basis, total hard drive exabyte shipments increased by 27%. As we move to costs and expenses, please note that my comments will be related to non-GAAP results unless stated otherwise.

 

Gross margin for the second quarter was 33.6%, down 0.3 percentage points, sequentially. As noted earlier, the COVID related impact was $10 million higher than we anticipated at $70 million. Our flash gross margin was 36.1%, down 0.9 percentage points, sequentially. This included COVID related impact of $10 million, or approximately 0.4 percentage points.

 

Our hard drive gross margin was 30.6%, down 0.3 percentage points, sequentially. This included COVID-related impact of $60 million, or approximately 2.7 percentage points.

 

Operating expenses of $741 million were below our guidance range due to prudent cost control and lower variable compensation expense. Operating income was $882 million, representing a 7% decrease from the prior quarter and 157% increase year-over-year, highlighting our ability to drive profitable growth.

 

Earnings per share was $2.30, which exceeded the high end of our guidance range. Operating cash flow for the second quarter was $666 million and free cash flow was $407 million. Despite a slight increase in inventory due to supply chain disruption, we maintained strong cash flow generation in the quarter.

 

Capital expenditures, which include the purchase of property, plant and equipment and activity related to our flash joint ventures on our cash flow statement with the cash outflow of $259 million. We remain prudent in investing in manufacturing capacity and continue to expect growth CapEx for the current fiscal year to be around $3 billion. We now expect to cash CapEx to be around $1.5 billion as we actively manage our overall spending.

 

As we mentioned on our last earnings call, we fully repaid our Term Loan B in the amount of $943 million last October. In addition, last December, we closed a public offering of $1 billion in senior unsecured notes and repaid 1.3 billion on our Term Loan A, bring in our gross debt outstanding to $7.4 billion at the end of the fiscal second quarter.

 

On top of that, earlier this month, we entered into an agreement with our lenders to revise the terms of our loan agreement to reflect our improved credit ratings and to extend the maturity of our Term Loan and revolving credit facility from 2023 to 2027.

 

Our trailing 12-month adjusted EBITDA at the end of the second quarter as defined in our credit agreement was $4.8 billion, resulting in a gross leverage ratio of 1.5 times. This compares to 3.0 times in the third fiscal quarter of 2020, when we announced the plan to focus on debt repayment to achieve greater financial flexibility.

 

As a reminder, our credit agreement includes $1 billion in depreciation add back associated with the flash ventures. This is not reflected in our cash flow statement. Please refer to our earnings presentation on the Investor Relations website for further details.

 

Considering the transitory supply chain challenges, we discussed earlier, I would like to provide a bit more color on our view of both, hard drive and flash businesses in calendar 2022.

 

Within our hard drive segment, we expect hard drive revenue to decrease on a sequential basis in the third fiscal quarter. While the supply chain disruptions at some of our customers are expected to remain, the larger issue of late has been our ability to source components to meet customer demand. We expect revenue to return to sequential growth in the fiscal fourth quarter.

 

While overall hard drive pricing is expected to remain relatively stable, we expect gross margins to decline 2 percentage points to 3 percentage points from the fiscal second quarter through the fiscal fourth quarter due primarily to component cost inflation.

 

Within our flash segment, we expect flash revenue to decrease on a sequential basis in the fiscal third quarter driven by ASP. We expect flash revenue to return to growth in the second half of calendar year 2022. Furthermore, we anticipate downward pressure on gross margins for the first half of this calendar year as cost reductions revert towards our long-term target of 15%.

 

In regard to our fiscal third quarter, our non-GAAP guidance is as follows: We expect revenue to be in the range of $4.45 billion to $4.65 billion, with a sequential revenue decline for both, flash and hard drive businesses. We expect gross margin to be between 30% and 32%. We expect operating expenses to be between $750 million and $770 million. Interest and other expenses are expected to be approximately $70 million. Our tax rate is expected to be approximately 11% in the third quarter and for the fiscal year. We expect earnings per share to be between $1.50 and $1.80 in the third quarter, assuming approximately 318 million fully diluted shares outstanding.

 

I'll now turn the call back over to Dave.

 

David Goeckeler: Thanks, Bob. Looking ahead, we remain optimistic about our business outlook in calendar year 2022 as our customers continue to indicate strong end demand across cloud, client and consumer end markets. Despite the transitory issues we discussed earlier, it is clearer than ever that we have the right foundation for long-term growth and the right technology portfolio in place to ensure that we are successful in scaling our business.

 

Over the last couple of years, we have made significant changes necessary to improve our focus, sharpen execution and set strategic goals to place Western Digital in a position of greater strength, and I'm excited that we are starting to see the fruits of those changes.

 

Before I finished today, I'd like to take a moment to comment on the CFO transition we announced earlier this afternoon. As you may have seen, we announced that Wissam Jabre will be joining Western Digital as Chief Financial Officer, effective the week of February 7. Wissam was most recently Chief Financial Officer at Dialog Semiconductor. In addition to his deep financial and semiconductor expertise, Wissam also has technical expertise. And importantly, shares Western Digital's values of collaboration and innovation. You can read more about his background in the press release issued today.

 

I'd like to extend my sincere thanks on behalf of the entire board and management team to Bob, for his dedication and hard work at the service of Western Digital. During my tenure as CEO, I've greatly benefited from his friendship and expertise. He's been an essential part of our leadership team guiding key aspects of our strategy.

 

Among many other contributions, Bob drove a capital allocation strategy that has led to significant repayment of our debt, marked this quarter by Western Digital second investment grade corporate rating. Bob's insight was also instrumental in helping us navigate COVID uncertainty, and execute other strategic changes at the company to position us for growth and value creation.

 

Next quarter, you'll have an opportunity to hear from Wissam. I know he's looking forward to it. With that, Peter, let's begin the Q&A.

 

Q&A

 

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